Financial Institutions and Banking

Should Community Banks Think About ESG Initiatives?

An increasing number of organizations — including many banks — are embracing environmental, social, and governance (ESG) initiatives. Although being a good corporate citizen may be its own reward, there’s evidence that responsible ESG practices may produce ample financial benefits.

What is ESG?

ESG generally refers to:

  • Environmental practices, including your bank’s use of energy, production of waste, and consumption of resources,
  • Social practices, including fair labor practices, worker health and safety, diversity and inclusivity, and other aspects of your bank’s relationships with people, institutions, and the community, and
  • Governance practices, including business ethics, integrity, openness, transparency, legal compliance, executive compensation, data protection, and product quality and safety.

Simply put, ESG means recognizing your bank’s impact on the environment and the people and institutions it interacts with.

Why should you care?

In recent years, pressure has been increasing on all businesses, including banks, to adopt responsible ESG practices. This pressure has been coming from a variety of stakeholders. For example, customers are increasingly considering ESG issues — such as product safety, environmental impact, and fair labor practices — when deciding which organizations to do business with. And many investors are making ESG a priority when deciding where to invest their capital.

Consider this: The U.S. Forum for Sustainable and Responsible Investment reported that from 2018 to 2020, the value of U.S. assets managed according to ESG principles increased from $12 trillion to $17 trillion. This represents one-third of all assets under management.

Another reason to adopt ESG practices is its potential impact on financial performance. A number of studies have shown that embracing ESG can lead to higher sales, reduced costs (including energy and compliance costs), and increased access to capital. Consulting firm McKinsey reviewed more than 2,000 academic studies of ESG and found around 70% report a positive relationship between ESG scores and financial returns, whether measured by returns on equity, profitability, or valuation multiples.

ESG also may improve a bank’s ability to attract and motivate talented employees — a significant benefit given the ongoing shortage of qualified workers. According to McKinsey, “A strong ESG proposition can help companies attract and retain quality employees, enhance employee motivation by instilling a sense of purpose, and increase productivity overall.”

Will ESG initiatives be mandated?

To date, ESG initiatives have been voluntary, but that could change as federal financial regulators are starting to pay more attention to ESG issues. For example, the FDIC and Office of the Comptroller of the Currency (OCC) have issued draft principles for managing exposures to climate-related financial risks. Although the proposals target larger banks, regulators have indicated that they expect community and midsize banks to develop climate-related financial risk management practices. The Securities and Exchange Commission has also proposed ESG disclosure requirements for companies it regulates. And the Federal Housing Finance Agency (FHFA) has added “resiliency to climate risk” to its list of institution assessment criteria.

Finally, although not yet required, an increasing number of companies are incorporating ESG information into their financial reports, combining nonfinancial and financial information into an integrated report. Many experts believe that these reports provide a more accurate picture of a company’s long-term value-creation potential. Banks should consider whether they should prepare this type of report or ask their customers to do so.

Can ESG initiatives benefit your bank?

Adopting ESG initiatives is viewed by many as a best practice, but it may very well be required — or at least strongly encouraged — by regulators in the future. Banks might benefit from evaluating the ESG impact of their activities and considering ways to incorporate ESG practices and initiatives into their operations.

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